What to Expect from Stabilization and Reforms: Lessons of Interest to Cuba

To control inflation and emerge from stagnation in production, Cuban authorities must launch a comprehensive three-pronged transformation program addressing macroeconomic stabilization, unification and restructuring of the currency exchange system, and structural reforms (Alonso and Vidal, 2023).

This article presents a summary of the experiences and lessons in the region based on extensive studies organized by international financial institutions, and of other academic articles containing considerations and recommendations based on the outcomes in developing economies, especially in Latin America.

More than in previous decades, the current literature provides a renewed and much more considered view of fiscal and monetary policies, structural reforms, and debt management.

This literature has been filtered, arriving at a selection of some of the lessons and experiences that may be most relevant to the Cuban scenario concerning issues such as macroeconomic stabilization and structural reforms. Although the political context and starting point of the Cuban economic model contain unique elements, it is crucial to try to transcend the rationale of Cuban exceptionalism. Otherwise, the analysis devolves into debates and proposals that completely ignore the relevant literature and its outcomes elsewhere.

The benefit of knowing the outcomes in other places does not lie in being able to predict exactly what is going to happen in Cuba, but in having a bit more clarity about the opportunities and limitations, as well as about the challenges that economic policies and reforms will likely face. The studies refer to mean or oft-repeated experiences, but acknowledge the diversity of the results in the specific context of each nation.

Instead of making a wish list of everything that the Cuban government should change, this brief article takes a look at what has happened in other economies that have had to seek out formulas to contain inflation and reform their production systems. The hope is that it will contribute to enriching the discussion about the Cuban situation at a time when the government seems to have run out of ideas on how to deal with the precarious economic situation. Social media are flooded with debates that prioritize delegitimizing the opponent without providing valuable arguments on how to get out of the crisis.

The literature confirms the broad range of factors that can influence results and the complexities inherent in managing economic transformation programs. However, the Cuban government must weigh these challenges and risks against the cost of doing nothing in a country that is going through one of its worst social and migration crises.

Results from the foreign sector and access to financing are variables that determine impact on programs.  The international community should support Cuban reforms if the government were to display a real political will to implement them.

Macroeconomic Stabilization

After World War II and until the 1980s, inflation in Latin America remained at between two- and three-digit rates. During the 1980s, monetary instability worsened, with episodes of hyperinflation occurring in countries such as Argentina, Bolivia, Nicaragua, and Peru.

In the late 1990s, thanks to significant advances in macroeconomic policies and institutions, the independence of central banks, fiscal consolidation, and the adoption of inflation targets to steer monetary policy, most Latin American economies managed to control inflation (De Gregorio, 2019).

The greater stability of domestic prices was also influenced by a global phenomenon of lower inflation due to increased competition, globalization, and deregulation, as noted by Rogoff (2004).

On stabilization programs in Latin America in the 90s, the study by Singh et al. (2005), published by the IMF (International Monetary Fund), offers the following conclusions:

• In general, stabilization plans were effective in promptly reducing inflation and maintaining it at single-digit rates.

• In some cases, results were compromised due to increased dollarization and low export growth.

• GDP (Gross Domestic Product) growth accelerated in the first half of the decade, but then lost momentum. Poverty and income inequality trends did not experience a substantial improvement in that period. It was a factor that undermined support for reforms and public institutions.

• Inflexible exchange rates hurt economies, especially because they were not backed by adequate fiscal policies.

• In the fiscal area, there were increases in debt and failures in tax collection mechanisms. When measures were adopted, they consisted of cuts in government spending on infrastructure, increases in distortionary taxes, and reductions in social spending, all of which harmed long-term growth and popular support for reforms.

• Better fiscal results were observed in countries that succeeded in strengthening their fiscal institutions by adopting fiscal rules and budgeting procedures that fostered discipline and transparency.

• Corruption and weakness in the running of governments tended to undermine market activity, with poor families being the most affected by these inefficiencies.

• Progress has yet to be seen in new structural and institutional reform programs supporting macroeconomic policies. To advance on both fronts—macroeconomic and structural—it is necessary to have popular support, which must be fostered by establishing social protection networks and reducing corruption.

After the COVID-19 pandemic, inflationary trends reemerged in Latin America, although failing to reach the rates of previous decades. In fact, there are already signs that inflation is on the decline. International financial institutions have been insisting on the need to prioritize reducing inflation so as to avoid prolonging its destabilizing effect and its impact on inequality and the most vulnerable sectors of the population.

Increasing interest rates is as important for controlling inflation as are fiscal policy tools. However, achieving a fiscal adjustment is not easy due to the high demand for social spending in the region, along with significant distribution- and social equity-related issues requiring attention. Efficiency in public spending must be fostered to generate savings, thereby avoiding cuts in essential social programs and in investments in health, education and public infrastructure (Adler and Chal, 2023).

A recent IDB (International Development Bank) study (2023) analyzes the importance for the region to maintain prudent debt levels, for which it is essential to consolidate fiscal stabilization and continue developing solid and credible fiscal institutions. Prudent debt levels are deemed to be between 46% and 55% of the GDP for the region as a whole. Debt over 60% of the GDP indicates excess public debt in regional economies, although the specific thresholds depend on each country’s internal factors.

The study concludes that an adequate level of debt serves to limit the amounts allocated to interest payments, allowing governments to use their revenue to invest in social projects and infrastructure. Furthermore, low debt levels leave economies better positioned to withstand external shocks when they arise, minimizing the risk of a debt default crisis and the implementation of procyclical policies.

Fiscal institutions, such as fiscal rules that limit over-indebtedness, constitute an essential element of fiscal stability. It is important that fiscal rules have a solid legal basis, credible and transparent enforcement mechanisms, and an independent fiscal council.

To reduce debt and fiscal deficit, countries must focus on improving the efficiency of both spending and tax collection. IDB estimates (2023) show that improving the efficiency of public spending could generate savings of more than 4% of the GDP in the region. Addressing fiscal imbalances through spending efficiency is crucial in economies where public revenue and spending are high when taken as a percentage of GDP. In these cases, raising taxes can be counterproductive: it is preferable that fiscal savings come from cuts in inefficient spending.

Structural reforms

In the IMF report (2019), the results of structural reforms applied in ninety economies during the 1973–2014 period were evaluated with data and econometric instruments. The study examined reforms in the areas of external financing, internal financing, trade, product market, labor market, and governance. The document also consolidated ideas from several academics on reform processes. David, Komatsuzaki & Pienknagura (2020) then followed up this statistical analysis by examining the effect of structural reforms on the economies of Latin America and the Caribbean only.

Although the reforms do not all coincide exactly with those that should be be implemented by the Cuban government, it is interesting to know some of the main conclusions and policy lessons that emerge from this exhaustive analysis. Below is a summary of some that seem most relevant to the Cuban situation:

• In general, reforms usually take time to take effect. It takes at least three years to see significant positive effects on the GDP, although some reforms, such as the deregulation of product markets, tend to yield results more quickly.

• Reforms have a positive effect on medium-term growth. On average, an additional 1% increase in sustained GDP growth over several years is estimated to be attributable to reforms.

• Reforms could lead to gains greater than this 1%, and have more lasting impacts, if they furthered progress in two key areas: 1) Increasing the capacity of the business and governmental systems to innovate, and 2) improving the resilience of economies in the face of economic and financial crises.

• In the specific case of Latin America and the Caribbean, the results indicate that reforms have positive effects on the employment rate and GDP, which reach 2% after five years. Reforms boost investment, exports, imports, reduce export concentration, and favor the tradable sector of the economy. Results also indicate that in many cases reforms can have adverse effects on inequality and poverty (effects are economically small, but statistically significant).

• Some reforms (e.g., domestic financial liberalization) may entail higher short-term costs when implemented during times of hardship. In such cases, it is advisable to try to apply them in a more favorable context.

• Reform benefits tend to be greater when there is adequate government management and access to credit. The absence of these factors constitutes a major impediment to greater economic growth.

• Contrary to what one might think, reform benefits are greater when informality is higher. This can be explained by the fact that one of the positive consequences of reforms is that they help reduce such informality.

• No reform package exists that is effective for all economies. It is crucial to adapt reforms to each country's unique circumstances to maximize their benefits.

• The sequence and order of reforms is of fundamental importance. It is better to implement some reforms in times of relative prosperity. Achieving the proper combination, complementarity and sequence of reforms determines the final result.

• Addressing issues related to inequality is essential to legitimize the reforms and maximize their effect on economic growth. Without a redistribution of wealth through the tax and social assistance systems, many structural reforms can generate very different gains among sectors of the population. Reforms whose benefits are felt by only a small proportion of society risk losing support and even being blocked.

• Crises often represent turning points and act as a catalyst for reform. In crisis scenarios, popular support for reforms grows, as the cost of maintaining the status quo increases. Nevertheless, significant resistance may emerge from societal groups who do not benefit initially or if the government lacks the ability to inform the public of what to expect. This can be problematic, as often gains from reforms may be diffused widely among the public, making them less visible.

References

Alonso, J. A., y Vidal, P. (2023). “Why is Cuba’s Economic Reform Progressing so Slowly?’, Third World Quarterly, 44(1), 115-133.

Adler, G. y Chal, N. (2023). La política fiscal puede facilitar la tarea de los bancos centrales en América Latina. IMF blog

BID (2023). Lidiar con la deuda: menos riesgo para más crecimiento en América Latina y el Caribe / editores, Andrew Powell, Oscar Mauricio Valencia. Washington

David, A., Komatsuzaki, T., & Pienknagura, S. (2020). The Macroeconomic Effects of Structural Reforms in Latin America and the Caribbean1. IMF Working Papers 195.

De Gregorio, J. (2019). Inflation Targets in Latin America. Peterson Institute for International Economics. Serie de Documentos de Trabajo 490. https://ideas.repec.org/p/udc/wpaper/wp490.html

Fondo Monetario Internacional (2019) “Reavivar el crecimiento en las economías de bajo ingreso y de mercados emergentes: ¿qué papel pueden cumplir las reformas estructurales?, en Capítulo 3: Perspectivas de la Economía Mundial, octubre, Washington

Rogoff, K. S. (2004). Globalization and Global Disinflation. Monetary Policy and Uncertainty: Adapting to a Changing Economy: 77-112. Federal Reserve Bank of Kansas City.

Singh, A., Belaisch, A. A., Collyns, C., De Masi, P., Meredith, G. M., , Krieger, R., & Rennhack, R. (2005). Estabilización y reforma en América Latina: perspectiva macroeconómica desde principios de los años noventa. Occasional Paper 238, FMI.